United Kingdom: 2014 Article IV Consultation-Staff Report; Press Release; and Statement by the Executive Director for the United Kingdom

Summary:KEY ISSUES
The economy has rebounded strongly and prospects are promising. Headwinds that
previously held back the economy—relating notably to credit conditions and
confidence—have eased. Nonetheless, sustaining strong growth will depend on a
recovery in productivity growth and further demand rebalancing. The housing market
brings risks of financial vulnerabilities. Sterling is moderately overvalued.
The overall policy mix is appropriate, but policy settings might need to be adjusted
quickly. Effective monetary conditions are very supportive, compensating for ongoing
fiscal consolidation:
? Accommodative monetary policy is appropriate for now, given weak inflation
pressures, but policy might need to be adjusted quickly if inflation takes off. Interest
rate increases may also need to be considered if macroprudential tools are
insufficient to deal with financial stability risks from the housing market.
? The authorities have recently implemented macroprudential measures, including
limiting the share of high loan-to-income mortgages lenders can issue, establishing
them as the primary defense against housing-related risks. They should stand ready
to tighten these limits should current settings prove ineffective in reining in those
risks.
? A lasting solution to house price pressures requires measures to address insufficient
supply. Significant planning reforms have been undertaken, but political consensus is
needed to make further progress in this area.
? High deficits and rising debt mean that fiscal consolidation needs to continue. The
pace and composition of deficit reduction over the near term is appropriate. Further
reducing the deficit over the medium term will be challenging; both revenue and
expenditure measures should be considered, keeping in mind both equity and
efficiency.
? The financial sector is more robust, the new financial architecture is settling in, and
significant changes have been made to banks’ liquidity backstops to adapt to
changing needs. Implementing macroprudential policy will be a test of the new
architecture. Some problems—such as Too Important To Fail and bank misconduct—
persist, and new challenges, such as from shadow banking, are emerging.